Europe’s Rescue Plan Meets Reality. Which Will Win?

Summary: The dream of the latest Euro-rescue plan lasted for one week. Already painful reality emerges to confront the bold but baseless claims of Europe’s leaders. Only with exceptional skill and determination can they make this work.

Content

Greece introduces democracy into the rescue process

Red lights on the dashboard

The BRIC rescuers sound wary about their assigned role

Market-based solutions fail if investors refuse to play

Deductions and guesses

(1) “Papandreou says new Greek plan must be put to referendum”. The creditor nations of Europe have put severe stress on their debtor neighbors. So far the people have accepted these measures with remarkably little fuss. For example, Spain has an unemployment rate of 20%+ and rising.

But there are limits to what external pressure can accomplish, and the recent strikes and riots suggest that limit may be near. Asking the people for their consent is a logical and bold step. They may approve — large majorities favor staying with the Euro. They might not (Iceland’s voters rejected assuming their bankers’ debts). It introduces yet another uncertain element to a process in which time is the scarcest element.

(2) What is best market-price indicator of stress in the euro-zone?

Italian government bonds. The crisis entered a new phrase in August when their benchmark ten-year bond yield exceeded 6%. After the announcement of the Plan — it’s 6.17%. Continued increases would put the solvency of Italy at risk.

(3) Brazil, China and Japan make cautious indications of disinterest in the special vehicle bonds of the EFSF.

(4) A weak reception of the new EFSF bond auction: EFSF scales back Irish bailout bond”, from yesterday’s Financial Times:

The eurozone rescue fund has scaled back a planned bond issue designed to finance the bail-out of Ireland amid uncertainty over the level of demand. … The bond from the {EFSF} will only target €3bn, instead of €5bn, and will be in 10-year bonds rather than a 15-year maturity because of worries over demand. … The bond is expected to price at yields of about 3.30%, and about 130 basis points over Germany, the European market benchmark. This is a big mark-up since the middle of September, when existing 10-year EFSF bonds were trading around 2.60% and only 70bp over Germany.

(5) Deductions and guesses

These are not random isolated events, but steps in a larger process. Here are my guesses.

The rescue plan will be seen as a failure. The ring fence around Greece was imaginary, the bank recapitalization a farce, the writedown of Greek debt insufficient, the EFSF plan a dream.

The hopes the Plan aroused might slowly fade. Or they might pop, like an bubble or illusion.

Europe’s leaders burned both time and credibility in this failed effort, just like the previous ones during the past 21 months.

Now Europe’s problem will be seen as regional, not just Greece.

As a result of these things the next rescue plan probably becomes 10x more difficult.